Institutional investors' growing participation in the leveraged-loan market has spurred the creation of new products and broadly transformed the lending landscape.
As a group, insurance companies, retail loan funds, and hybrid loan and bond funds now account for the largest part of the leveraged-loan market. These institutions have bought 37% of leveraged loans so far this year, according to Portfolio Management Data LLC.
In addition, there are now 59 nonbank investors in the market, according to Portfolio Management Data. In 1993 only 14 nonbank investors, mostly prime-rate retail funds, regularly committed capital to bank loans.
"Because institutional investors are now the largest piece of the investor base, it means that as syndicators we have to think about deals with that investor base first and foremost in our mind," said Eric Swanson, managing director in syndications at Donaldson, Lufkin & Jenrette.
Seeking a combination of high yield and security, institutional investors participate almost exclusively in the leveraged and highly leveraged bank loan markets, where credits are priced at least 125 basis points over the London interbank offered rate.
In the past four years, tranches of loans designated for institutional investors have become a standard feature of most multifacility credits, known as institutional or "alphabet" tranches due to their designation as Term Loan A, B, C, D, and even E. They typically carry terms of six or more years - longer than the standard five-year terms of revolving credits designated for banks.
One result of the added liquidity brought to the market by institutional investors, lenders say, is that they can now syndicate loans with institutional tranches of $1 billion or more, a feat many saw as impossible as recently as last year.
But one of the most notable effects this year of the new investors' rise to dominance in the leveraged-loan market has been the success of so-called hybrid structures.
First used by BT Alex. Brown in a $135 million tranche of a loan for Huntsman Specialty Corp. completed in the first quarter, the structure replaced an identically sized subordinate bond offering. Featuring bond- like structures, such as no amortization, three-year call protection, and a 10-year term, the credit was followed by nearly 20 loans syndicated this year that featured some form of a hybrid tranche.
For example, Donaldson, Lufkin & Jenrette's $200 million hybrid tranche for Total Renal Care Corp., syndicated in the third quarter, was so oversubscribed that the credit was enlarged to $250 million. That made it the largest hybrid syndicated to date.
"Hybrids are now a permanent fixture of the leveraged-loan market," said Mr. Swanson.
The convergence of the leveraged-loan and high-yield bond asset classes is mirrored by the crossover of investors from the bond market to loans.
"The convergence you've heard about is well under way, both in terms of products and investors," said Scott Krause, principal of Oak Hill Advisors Inc., which manages a $1.75 billion fund of loans and bonds.
But institutional investors have affected more than just the structure and term of loans, said lenders.
Where bank lenders typically require weeks of analysis and procedure before they can commit their banks to a loan, institutional investors "sped up the syndication process" in that they "are accustomed to making investment decisions much more rapidly than the traditional market," said Mr. Swanson.
Noting that on the most sought-after credits, a lender may get all the necessary commitments at the end of the bank meeting that opens the syndication process, Mr. Krause said, "It's two days now, or you're out."
The leveraged-loan market is also more efficiently priced because of the presence of institutional investors who are driven by yield rather than banking relationships, said lenders and investors.
Although only 3% of institutional tranches syndicated in 1993 featured pricing grids, which tie a loan's interest rate to a borrower's performance, 48% of those syndicated this year now use them, according to Portfolio Management.
"Inefficient markets meant you could make money more easily," said John W. Petchler, second vice president at Travelers Insurance Co., which has $3.25 billion invested in loans.
In response to demand for more standardized measurement of loans from institutional investors, credit rating agencies, including Standard & Poor's, Fitch IBCA, and Moody's Investors Service, now rate loans in much the same way they rate bonds.
And several syndicated lenders, including BankAmerica Corp., BankBoston Corp., and Citicorp, have established groups to do the type of market research and analysis that is a cornerstone of the equity and bond underwriting businesses.